Wednesday, July 23, 2008

Ilargi: I’ll address one more time why that $25 billion cost estimate for the Fannie Mae and Freddie Mac bail-out is such a bogus number, and why it’s so insane that it will be used in Washington.

After all, there will be a vote today on the housing rescue bill that the bail-out was made an ill-fitting part of, and the Congressional Budget Office’s $25 billion number will be the official estimate used in presenting the bill. Which in turn means far-reaching policy and budget decisions will be based on it. Hard to believe, but that’s US politics these days.

The New York Times today basically repeats what I have said earlier about the estimate, but lacks the gutzpah to draw conclusions. The CBO claims there is a higher than 50% chance that Fannie & Freddie won’t use the rescue package at all, an assertion ostensibly based on the idea that they are "fundamentally sound".

Now, we’ve all seen some of the creative accounting used for the two, like the below-low capital requirements for them, but I still find it so unbelievable that Congress takes that for granted, that it makes me suspicious. How is that in the best interest of the people they have been elected to represent?

No company, not a single one, that is leveraged over 60 times, is fundamentally sound. It may seem that way for a short time as prices and markets soar, but even then it’s all just nothing but sleight of hand. As soar turns to sour, a loss of a mere few percent can wipe out all reserves.

In the case of Fan&Fred, of course, reserve requirements were loosened earlier this year at the very moment that markets soured, and they were actively pushed by Washington to increase their leverage even as it was crystal clear that the market downturn would cause them big problems.

Please note that of F&F’s $5.2 trillion portfolio, $1.5 trillion are mortgage securities and home loans they own, and $3.7 trillion are securities that they guarantee, held by other investors. Sure, F&F traditionally stayed away from subprime loans, a by now distant memory that nonetheless still guides regulating and apparently also cost estimates.

But what about that $3.7 trillion in third party securities? Those are not real assets, and never have been; when you peel off the skin, they are bets. When the underlying assets lose value, they can quickly become worthless.

Mortgage backed securities are now a dead industry, and Fannie and Freddie have been used by both Washington and Wall Street to trick people into thinking the corpse was still breathing. That has allowed the cream of society to hedge bets and cover positions.

Fannie and Freddie are not mortgage insurers, and they certainly are not well-capitalized or fundamentally sound.

Fannie and Freddie are casino’s, gambling dens that have been encouraged by the house, in this case the US government, to play double or nothing over the past year, and now count on the same house to cover their blackjack losses. Which the house is about to do, with your money.

And the Congressional Budget Office plays along. They are supposedly independent, but that’s nothing but a stale joke: if they really were, they would have taken their own statements to heart about uncertainties regarding Fannie and Freddie, and presented their paymasters in Congress with at least for instance an "fair estimate" range, not a fixed number .

That fair estimate would state that potential losses to the US taxpayer from the GSE bail-out would be between $25 billion and $2.5 trillion. And still add that the number could be much higher.

Because if - make that when- US home prices go down by 50% or more across the board, when banks open their books and vaults to reveal they have little else but toxic paper left, and unemployment starts hitting prime time, there will be a $5.2 trillion combined Fannie and Freddie portfolio waiting for a "fair estimate".

Today, with memories of the outrage over the $29 billion in public funds used on Bear Stearns still fresh on everyone’s mind, moral hazard will be taken not just to a whole other level, but into a different dimension, and a universe unknown to man. A small step for man, a giant leap for mankind. In hindsight, it now becomes clear that Bear Stearns was used as a test-case, and the timid response to that bail-out directly opened the doors for the biggest heist in the history of America.

Update 3.45 pm EDT - Ilargi: Just in case you thought I was making this up, here's someone who agrees. It's probably a false hope, but maybe the Senate, which discusses the plan tomorrow, has the guts and brain to kick a few deep holes in it.

Senator Jim Bunning calls the plan "horrendous", and I obviously agree. He does puzzle me, however, with this one -liner: " "What is good about this bill is the fact that maybe it shores up Fannie and Freddie for a temporary basis". What's it that's so good about that, Senator? Who is it good for?

A government rescue of Fannie Mae and Freddie Mac would require taxpayers to pay "way" more than the $25 billion estimated by the Congressional Budget Office, potentially as much as $1 trillion, Senator Jim Bunning said.

Treasury Secretary Henry Paulson "hasn't told us the truth about this bill," Bunning, a Republican from Kentucky, said in an interview with Bloomberg Television today. "Why would you put in a backstop of unlimited amounts of money if you weren't going to need it."

Paulson on July 13 asked Congress for authority to increase credit lines to Washington-based Fannie Mae and McLean, Virginia- based Freddie Mac, buy shares in the firms and give the Federal Reserve a "consultative role" in overseeing their capital requirements.

The proposals are meant to restore confidence in the government-sponsored enterprises, which own or guarantee almost half of the $12 trillion of U.S. home loans outstanding.

The House of Representatives is set to vote today on the rescue plan for Fannie Mae and Freddie Mac as part of broader legislation aimed at alleviating the worst housing slump since the Great Depression.

Bunning called the plan "horrendous." "What is good about this bill is the fact that maybe it shores up Fannie and Freddie for a temporary basis," Bunning said.

"What it does not do is change the model of Fannie and Freddie. It does not give the regulators the power to make the changes needed in Freddie and Fannie to make them viable entities for the future. That is why I object."

The proposed government rescue of the nation’s two mortgage finance giants should appear on the federal budget as a $25 billion expense, the independent Congressional Budget Office said on Tuesday, but officials conceded that there was no way to really know what, if anything, a bailout might cost taxpayers.

The budget office said the chances were better than even that a rescue would not be needed before the end of 2009 and would not cost any money. But the office also said there was a 5 percent chance that the mortgage giants, Fannie Mae and Freddie Mac, could lose $100 billion.

Lawmakers said that the $25 billion cost would not have to be offset with spending cuts or tax increases as would normally be required by “pay as you go” budget rules, and instead would be regarded as emergency spending and added to the national debt.

The budget office, while acknowledging that the $25 billion was, at best, a rough estimate, did not explain fully how it came up with the figure. The office said it analyzed the companies’ financial statements and consulted with regulators, analysts, market participants and the companies themselves to estimate possible future losses and the amount of any cash injection that might be needed from the Treasury.

The full $25 billion cost would appear on the government’s books in both fiscal years 2009 and 2010; the Treasury’s authority to aid Fannie and Freddie would expire at the end of 2009, or one-fourth of the way into fiscal 2010. Senator Jim DeMint, Republican of South Carolina, said lawmakers were generally supportive of the overall rescue plan, but he added that he had doubts about the $25 billion estimate.

“Everyone knows it’s just a wild guess,” Mr. DeMint said. “We are either going to spend zero or we’re going to spend a whole lot more than they are talking about.” The House is expected to vote as soon as Wednesday on housing legislation that includes the proposed rescue plan. The housing bill would also raise the national debt limit to $10.6 trillion, an $800 billion increase.

The higher debt ceiling gives the Treasury more room to aid the mortgage companies, but it could also stir opposition among fiscal conservatives. Tony Fratto, a White House spokesman, said Tuesday night that the bill was being reviewed by the White House, which has objected to a provision providing nearly $4 billion in grants to local governments to buy and rehabilitate foreclosed properties.

“It’s clear that the Democrats chose to play politics with the legislation, and it’s unfortunate that they’re doing it with legislation that will prevent systemic risk to our financial system,” Mr. Fratto said.

In a letter to the House Budget Committee chairman, John M. Spratt Jr., Democrat of South Carolina, the director of the budget office, Peter R. Orszag, predicted “a significant chance, probably better than 50 percent, that the proposed new Treasury authority would not be used before it expired at the end of December 2009.”

But Mr. Orszag, at a briefing with reporters, acknowledged that pinpointing the eventual cost of the package was impossible. “There is very significant uncertainty involved here,” he said. The uncertainty runs in both directions, with some government officials and market analysts suggesting that Fannie Mae and Freddie Mac are fundamentally sound and will perform well over the long term — a point that was emphasized again on Tuesday by the White House and by the Treasury secretary, Henry M. Paulson Jr.

Others, including some private equity managers, are pessimistic and predict heavy losses. The rescue plan, put forward last week by Mr. Paulson, would give the Treasury temporary authority to shore up the mortgage companies, either by extending credit or by purchasing equity in the companies, which are publicly traded.

“This bill requires an emergency designation before one dollar of federal funding can be used,” Representative Mike Ross, Democrat of Arkansas and a leader of the fiscally conservative Blue Dog coalition, said in a statement. “We are clearly facing an emergency situation and we must act now in order to secure the financial future of millions of homeowners.”

Mr. Orszag said that the analysis by his office did not distinguish between the different forms of aid that might be offered — a credit line or a stock purchase — and that it had no way to know under what circumstances help would be extended.

At the briefing, Mr. Orszag said his office expected that help would be offered if the mortgage giants experienced credit losses beyond the $85 billion in losses they have already recognized on their balance sheets as well as other losses they have not yet had to recognize.

Mr. Orszag said that the analysis showed no short-term potential financial benefit for taxpayers even if Fannie Mae and Freddie Mac performed well. But he said the analysis found substantial risk for taxpayers if the companies had steep losses. He would not say if his office had analyzed the implications of a full government takeover of the companies.

How much the government will end up spending on a rescue, if one is needed, would depend on many factors, he said, including sentiment on Wall Street. “A key question becomes, How does the market view the entities?” he said.

The rescue proposal has made the guarantee of government backing more explicit, and Mr. Orszag said that the government’s assurance that it would not let the companies fail would have to be included in any analysis of their long-term financial prospects.

The budget office projection also includes a sobering assessment of the mortgage companies. Under generally accepted accounting principles, Mr. Orszag said that the net worth of the mortgage giants at the end of the first quarter of 2008 was about $55 billion. He also said that the companies were considered to be “adequately capitalized” by the Office of Federal Housing Enterprise Oversight, which regulates them.

But on a fair value basis — or what the companies’ assets would fetch on the market today — the value of the mortgage companies’ assets exceeded their liabilities at the end of March by just $7 billion, a thin cushion considering that their total debt is $1.6 trillion. That explains why there have been numerous calls for the companies to raise additional capital.

One thing that is certain as a result of the rescue proposal is that the guarantee of government aid is now much more explicit, and Mr. Orszag said that the government’s assurance that it would not let the companies fail would have to be included in any analysis of their long-term financial prospects.

Most immediately, the $25 billion cost estimate provides a precise amount that Congress will have to offset with spending cuts or tax increases if lawmakers intend to comply with “pay as you go” budget rules in the House. Lawmakers could also decide that the $25 billion should be viewed as emergency spending and simply added to the national debt.

Freddie Mac and Fannie Mae should close down their business or split into private companies and not get government aid, investor Marc Faber said.

"They should close down Fannie Mae and Freddie Mac or what they should do is split them into 10 different companies and let them run as private companies," said Faber, who forecast the so-called Black Monday crash in 1987, in an interview with Bloomberg TV. "What Freddie Mac and Fannie Mae should right away do is not obtain any federal aid, but issue additional shares" to avoid using taxpayers' money in a rescue plan, he said.

Fannie Mae and Freddie Mac, which own or guarantee about half of the $12 trillion of U.S. mortgages, have fallen 31 percent and 41 percent respectively this month, on concern the companies have insufficient capital to cover writedowns and losses amid the mortgage-market collapse.

Faber said the "world may already be in recession," and reiterated a prediction for a "bust" in global markets. Markets may enter "a vicious cycle on the downside" whose worst scenario is a "colossal bust with inflation," as central banks are unable to manage the economic slowdown and faster growth in prices.

Still, Faber forecast the Standard & Poor's 500 Index may climb about 5.7 percent from current levels, to 1,350. Oil may drop $30 a barrel to "about" $100 in the near term, he said, although the "long-term" prospect for oil prices is to remain "tight." Stocks worldwide have tumbled this year, erasing about $11 trillion in value, as $467 billion in credit-related losses and accelerating inflation weigh on the outlook for economic and profit growth

U.S. lawmakers reached agreement on a rescue plan for Fannie Mae and Freddie Mac that the House may vote on tomorrow, Representative Barney Frank said.

Under a modified version of proposals made by the Bush administration, the Treasury Department would gain authority to inject capital into the two largest U.S. mortgage finance companies, through loans and equity investments.

The agreement is the clearest indication yet that Congress will approve a backstop for the beleaguered companies, which Treasury Secretary Henry Paulson said today is essential for safeguarding U.S. financial market stability. Lawmakers added the provisions to legislation that would create a stronger regulator for Fannie Mae and Freddie Mac and expand federal efforts to stem mortgage foreclosures.

"The package we have got is fully acceptable" to the Treasury and Senate lawmakers, Frank, a Massachusetts Democrat who chairs the House Financial Services Committee, told reporters in Washington today. "Nobody is for everything that's in it or got everything in it he wanted, but we negotiated a lot."

Treasury spokeswoman Brookly McLaughlin said in an e-mailed response to a question that the department is reviewing the language of the bill, which is 694 pages. Frank said lawmakers, defying a White House veto threat, decided to keep provisions for $3.9 billion to help local communities buy up foreclosed properties.

The Bush administration opposed the idea because it said it would aid lenders who now owned the vacated properties, not struggling homeowners. "It's clear that the Democrats chose to play politics with the legislation," White House spokesman Tony Fratto said in an e-mail, without mentioning any veto plans. He echoed McLaughlin that officials are reviewing the bill.

The Treasury would be barred from providing aid that would cause a breach in the federal debt ceiling under the agreement, a constraint aimed at limiting any taxpayer losses. The debt limit would be raised to $10.6 trillion from the current $9.815 trillion. The plan would give Paulson power to restrict the companies' dividend payments and require regulatory approval of the salaries of top executives.

The legislation would also raise the limit on the size of the mortgages the companies may purchase. The new cap would be $625,000, or the median home price plus 15 percent, whichever is lower, Frank said. Frank's counterpart in the Senate issued a statement indicating he backs the bill now progressing in the House.

"We have been engaged in extensive and largely fruitful discussions with our counterparts in the House" and with Bush administration officials, Democratic Senator Christopher Dodd said in a joint statement with Republican Senator Richard Shelby distributed by e-mail.

"We remain optimistic about the prospects for this legislation." Dodd, of Connecticut, chairs the Senate Banking Committee and Shelby, of Alabama, is the panel's top Republican. Paulson, who proposed a rescue program on July 13, reiterated today the plan is aimed at restoring investor confidence in the two companies.

Fannie Mae has dropped about 45 percent in the past month, and Freddie Mac has tumbled about 60 percent, on concern the companies have insufficient capital to cover writedowns and losses amid the mortgage-market collapse.

Lawmakers wrapped the plan into a housing bill that would create a program aimed to help an estimated 400,000 Americans with subprime home loans refinance into 30-year, fixed-rate mortgages backed by the government.

The legislation includes tax breaks to help prop up the housing industry, including what would be the equivalent of an interest-free loan worth as much as $7,500 for first-time homebuyers. The bill also would allow taxpayers who don't itemize their tax returns to temporarily claim a property-tax deduction, said Representative Richard Neal, a Democrat from Massachusetts and member of the Ways and Means Committee. States could offer an additional $11 billion of mortgage-revenue bonds to refinance subprime loans.

The Senate may vote on the legislation as early as July 24, said Jim Manley, a spokesman for Senate Majority Leader Harry Reid of Nevada. The bill would then go to President George W. Bush for final approval. A Congressional Budget Office estimate released today put the cost of Paulson's plan at $25 billion, a figure below the total that some lawmakers had expressed concern about.

"It's pretty good news -- a lot of people thought it would be much higher" Shelby said earlier today.

The White House said Wednesday that President George W. Bush has dropped his opposition to the housing package.

House and Senate leaders have largely hammered out a compromise deal on a mammoth package that would permit the government to bolster Fannie Mae and Freddie Mac in an emergency, overhaul supervision of the housing-finance giants and allow the government to insure up to $300 billion in refinanced mortgages.

Treasury Secretary Henry Paulson said it was easy for him to recommend that the president support the legislation despite some disappointing points contained within it, he said during a meeting with reporters Wednesday. "I am, as you can imagine, pleased the House and Senate reached an agreement on GSE reform," Mr. Paulson said, adding the legislation is "very important to the capital markets broadly and to confidence in these institutions."

The legislation is key to helping the U.S. turn a corner in the housing crisis, Mr. Paulson said. White House press secretary Dana Perino announced Mr. Bush's switch in a telephone conference call with reporters. "We believe this is not the time for a prolonged veto fight but we are confident the president would prevail in one," she said.

Mr. Bush had objected to the measure, saying that it was aimed at helping bankers and lenders, not homeowners who are in trouble. The congressional deal comes after tense negotiations and is likely to remain a source of contention when the House of Representatives votes Wednesday.

The nonpartisan Congressional Budget Office said Tuesday that a temporary measure to prop up Fannie Mae and Freddie Mac could cost the government as much as $25 billion. Lawmakers also plan to include a $4 billion program that would allow local governments to buy and rehabilitate foreclosed properties.

The bill is expected to easily pass the House and will likely pass the Senate. Many Democrats and Republicans have said fears about the fragile state of the financial markets necessitate action, and this bill is likely to be Congress's most expansive attempt to address the nation's housing woes this year.

"Nobody in America will agree with everything that is in this bill, but I think enough people in America will find it acceptable, so it will go to the president's desk to be signed," House Financial Services Committee Chairman Barney Frank (D., Mass.) said. Senate Banking Committee Chairman Christopher Dodd (D., Conn.) and Sen. Richard Shelby (R., Ala.) issued a joint statement saying they were "optimistic about the prospects for this legislation." The Senate could vote later this week.

The deal includes several compromises. It would allow Fannie Mae and Freddie Mac to purchase loans of as much as $625,000 in high-cost areas of the country, a lower number than many House Democrats wanted but higher than some Senate lawmakers originally envisioned.

It would also give the new regulator for Fannie Mae and Freddie Mac more control over the compensation packages received by top executives at either housing-finance giant, an unusual mark of government control over a publicly traded company.

In public, President Bush uses measured tones to describe the challenges facing the U.S. economy. At a private fundraiser in Houston last week, however, he was more frank.

"Wall Street got drunk -- that's one of the reasons I asked you to turn off the TV cameras -- it got drunk and now it's got a hangover," Bush said Friday, according to a video obtained by Houston's ABC affiliate KTRK. "The question is how long will it sober up and not try to do all these fancy financial instruments."

The video of Mr. Bush's remarks at a fundraiser for congressional candidate Pete Olson was posted on one of KTRK's blogs. The event, like many of the fundraisers Mr. Bush attends, was officially off limits to the press because it was held in a private residence. The provenance of the shaky video recording isn't known. But it provides a one-minute glimpse of Mr. Bush unfiltered, and a clue into where he plans to reside when his White House days come to an end in January.

"And then we got a housing issue, not in Houston, and evidently, not in Dallas, because Laura was over there trying to buy a house today," the president said, prompting some in the crowd to shout "Crawford," the small central Texas town where the Bushes own a ranch.

"I like Crawford," Mr. Bush said. "Unfortunately after eight years of asking her to sacrifice, I'm now no longer the decision maker. She'll be deciding, thanks for the suggestion. I suggest you don't yell it out when she's here." White House spokesman Tony Fratto said Mr. Bush's remarks, while colorful, don't break from what he has said publicly about the credit crisis and the explosion of complex instruments like credit default swaps.

"That description has been used for every market bubble in my memory," Mr. Fratto said. "The president has made the point before that a lot of market participants were using very complicated financial instruments without fully understanding what the impact would be under stress."

Mortgage rates are rising because of the troubles at the loan finance giants Fannie Mae and Freddie Mac, threatening to deal another blow to the faltering housing market. Even as policy makers rushed to support the two companies, home loan rates approached their highest levels in five years.

The average interest rate for 30-year fixed-rate mortgages rose to 6.71 percent on Tuesday, from 6.44 percent on Friday, according to HSH Associates, a publisher of consumer rates. The average rate for so-called jumbo loans, which cannot be sold to Fannie Mae and Freddie Mac, was 7.8 percent, the highest since December 2000.

Loan rates are rising because of concern in the financial markets about the future of Fannie Mae and Freddie Mac, which own or guarantee nearly half of the nation’s $12 trillion mortgage market. The federal government has proposed a rescue, and has urged Congress to approve it quickly.

But bond investors, worried that the companies may not be as big a support to the market as they have been, are driving up interest rates on securities backed by home loans. That added cost is being passed on to consumers through the mortgage markets. For a $400,000 loan, the increase in 30-year rates in the last few days would add $71 to a monthly bill, or $852 a year.

The rise in rates is of greatest concern for homeowners whose mortgages required them to pay only the interest on their loans for the first few years. If such borrowers are unable to refinance into lower-cost loans, many of them will face the prospect of having to pay both interest and principal at higher, adjustable rates.

For borrowers with a $400,000 loan, such a jump could send their monthly payments to $2,338 from $1,417, estimates Louis S. Barnes, a mortgage broker at Boulder West Financial in Boulder, Colo. While mortgage rates approached these levels earlier this year and in 2007 during times of stress in the financial markets, the latest move adds urgency to the government’s efforts to restore confidence in Fannie Mae and Freddie Mac.

Lawmakers are expected to vote this week on a measure that would give the Treasury Department authority to lend more money to the companies and buy shares in them if they falter. The uncertainty surrounding the two companies is the latest in a series of pressures bearing down on the housing market and the broader economy. Higher interest rates make it harder and more expensive to refinance existing debts and to buy homes.

“When we get to rate levels like this, the market just shuts down,” Mr. Barnes said. While mortgage rates remain relatively low by historical standards, they are higher than what homeowners and the economy became accustomed to during the recent housing boom. Lending standards have also tightened significantly in the last 12 months, and many popular loans are no longer available.

A government report based on data on Fannie Mae and Freddie Mac loans said on Tuesday that home prices fell 4.8 percent in May from a year earlier. That compared to a 4.6 percent decline in April. Other home price indexes that track a broader set of loans show much bigger declines. Worries about Fannie Mae and Freddie Mac have led to weaker demand for securities backed by home mortgages, analysts say. Inflation, which tends to send bond prices down and bond rates up, is another concern.

In a securities filing released on Friday, Freddie Mac suggested that it might have to pare or slow the growth of its mortgage portfolio to bolster its capital. Freddie and Fannie together own about $1.5 trillion in mortgage securities and home loans, and they guarantee an additional $3.7 trillion in securities held by other investors. The companies had a combined net worth of $55 billion as of March.

Analysts and critics say the companies need significantly more capital to cushion the blow of growing losses on the more-risky mortgages made during the boom. Important players in the mortgage market for decades, the two companies have become even more vital in the last year as several large lenders have gone out of business and investors have lost confidence in mortgage securities that are not backed by the government, or by Fannie or Freddie.

This year, the regulator overseeing the companies gave them more leeway to use their capital and the companies responded by increasing their portfolios. Freddie’s holdings grew 6.9 percent in the first five months of the year from the end of 2007; Fannie’s portfolio increased 1.8 percent. But now it appears the companies, particularly Freddie Mac, might have to slow their purchases of mortgage securities.

In its filing, Freddie Mac said it aims to increase its portfolio by a total of 10 percent in 2008. A spokeswoman for Fannie Mae declined to comment on its plans. “That’s one of the ways in which the agencies can increase capital, by slowing down their purchases,” said Derrick Wulf, a bond portfolio manager at Dwight Asset Management. “I don’t think the market expects a dramatic slowdown in purchases but there clearly is uncertainty about that.”

Mortgage rates have been driven up in part by a rise in the yield on Treasury notes and bonds. On Tuesday, bond prices, which move in the opposite direction of the yields, slumped after the president of the Federal Reserve Bank of Philadelphia, Charles I. Plosser, said the central bank might need to raise interest rates to combat inflation “sooner rather than later.”

Some analysts say the rise in mortgage rates can be explained by technical factors in the bond market that are forcing mortgage companies and banks to sell securities to manage their portfolios. These analysts add that at current prices the mortgage securities guaranteed by Fannie and Freddie should be attractive to investors.

Mortgage bonds backed by Fannie Mae, for instance, are trading at a 2.1 percentage point premium to the 10-year Treasury note, up from 1.8 points on July 14. “I don’t see how anyone could argue that the fundamentals of mortgages are not attractive,” said Matthew J. Jozoff, an analyst at JPMorgan.

The FDIC is looking for ways to shore up its depleted deposit fund, including charging higher premiums on riskier brokered deposits, FDIC Chairman Sheila Bair said Friday. However, that fund is "a myth," according to longtime banking consultant Bert Ely, and consumers may end up paying the price of what is expected to be a growing wave of bank failures.

NYU Economics Professor Nouriel Roubini predicts that Congress will have to intervene in order to bail out the deposit fund. "They're going to run out of money, with certainty," he predicted. "Congress is going to have to recapitalize the FDIC, those $50 billion plus is not going to be enough, by no means."

Indeed, on Friday afternoon FDIC Chairman Sheila Bair said in an interview on C-SPAN television that banks holding brokered deposits may be charged higher premiums in order to bring back the reserve to an acceptable size.

"I think that is something we need to factor into our premiums and charge higher premiums to banks that fit that profile," she said in the interview, noting that the IndyMac failure was a big factor in the need for additional funds in the deposit insurance fund.

This means higher premiums for FDIC insured banks, analyst Ely noted, further complicating an already tenuous situation for the U.S. banking system. Banks will most likely pass the increased costs onto their customers, he said. "Banks are going to pass it through to their customers through higher interest rates on loans, lower interest on deposit," Ely predicted.

The FDIC has around $53 billion set aside to back up bank deposits up to $100,000 per depositor, one of the ways the organization is designed to ensure confidence in the banking industry. However, according to Ely, that $53 billion is "not really available."

"The deposit insurance fund is as real as the social security trust fund," Ely said, noting that only a "small fraction" of the $53 billion is actually available and "any losses beyond that will be assessed on the banks."

The reserve, as of March 31, was valued at $52.843 billion, or 1.19 percent of the total insured deposits of $4.431 trillion. According to the Deposit Insurance Reform Act, the FDIC must have at minimum 1.15 percent of all insured deposits in the fund, with a target rate of 1.25 percent.

The failure of IndyMac, which is estimated to cost the deposit fund at minimum $4 billion, brings the target below 1.15 percent, forcing the FDIC to adopt a restoration plan that will restore the Deposit fund to 1.15 percent within 5 years, according to the Reform Act.

"The $4 billion loss would drop the fund down to about 1.10 ratio," Ely explained. "The FDIC is going to be obligated of an increase in premiums to pay for that loss, so the only monies that are available $2.843 billion in the fund, of that $50.966 billion was not available."

Ely noted that any loss over $1.877 billion would have brought the ratio below 1.15 percent, meaning that losses are going to have to be assessed back to the banks.

After the last week brought another round of woeful quarterly results from the industry, capped by news on Tuesday of multibillion-dollar losses at the Wachovia Corporation and Washington Mutual, that question is nagging banking executives and their investors.

Kenneth D. Lewis, the chief executive of Bank of America, insisted this week that the industry was turning the corner, after his company reported a mere 41 percent drop in profit. Many investors seem to see signs of hope in red ink that once would have shocked them. But it has now been a year since the credit crisis erupted, and, so far, the optimists have been proven wrong time and again.

Skeptics say it could take years for banks to recover from the worst financial crisis since the Depression. And even when things do improve, the pessimists maintain, banks’ profits will be a fraction of what they were before. There are many reasons for caution. Home prices continue to decline, and defaults are accelerating on a wide range of loans. As lenders struggle, loans are becoming even more scarce for hard-pressed consumers and companies. That, in turn, could slow any recovery in the broader economy.

For now, at least, some investors seem to have become so inured to the bad news that results that would have once been viewed as disastrous are now seen as good, or even great. The sober phrase often used on Wall Street to describe solid corporate results — “better than expected” — has been replaced by “not as bad as feared.”

“We are resetting expectations for bank profitability, and we are re-exploring what our expectations should be going forward,” said Christopher Whalen, managing partner of Institutional Risk Analytics. “We are redefining bad.”

That was clear on Tuesday, when Wachovia posted $8.9 billion second-quarter loss — and its stock subsequently rose 27 percent. Shares of Washington Mutual, rose 6.2 percent as that company reported a $3.3 billion loss. Investors cheered even though Washington Mutual said a record number of borrowers were unable to keep up with mortgage payments.

Fifth Third Bank and KeyCorp, two lenders based in Ohio, fell short of analysts’ earnings estimates and posted big losses, but their share prices shot up, too. SunTrust Banks of Atlanta reported a 21 percent drop in profit, reflecting bad real estate loans. No matter. Its stock rose 16 percent after telling investors it would not need to raise capital after selling its stake in Coca-Cola.

Longtime industry executives warned that investors may be getting ahead of themselves. “The market believed that this bad news was going to get dramatically worse — quickly,” said John Kanas, the former chief executive of North Fork Bank. “The bad news is going to get dramatically worse, but it will take time.”

For many banks, the housing crisis is entering a new — and potentially even more dangerous — phase. The problem is no longer subprime mortgages or complex investments tied to them, but rather the slowdown in the economy, which will make it more difficult for companies and consumers to keep current with their creditors.

Banks are pulling back. In the last six weeks, lending nationwide has remained flat after peaking at a record high, according to Federal Reserve data. “We’ve gone from a credit crisis to a credit crunch,” said Ed Yardeni, chief investment strategist of his own research firm. “It could be more damaging to economy than it has so far.”

The recent bath of bank results underscored that many borrowers are in trouble already. Wachovia reported a sharp rise in defaults on so-called pay-option mortgages that were a hallmark of the housing bubble. Plunging home prices, particularly in Florida and California, have left 14 percent of the bank’s customers with zero or negative equity in their homes. Wachovia’s big portfolio of commercial real estate is suffering losses too.

The problems extend beyond well beyond housing. Delinquencies on auto, credit cards, and home equity loans have worsened across the industry. Even affluent people with sterling credit scores are falling behind on payments, as results this week from American Express showed.

Once people fall behind, “the likelihood that they will make good on the debt is much lower than it has been in the last five to 10 years,” said Michael Poulos, a financial services consultant at Oliver Wyman in New York. “If we have significant unemployment or a recession, that is what I would worry a lot about.”

Washington Mutual Inc., the biggest U.S. savings and loan, reported a $3.3 billion second-quarter loss as tumbling home prices left a record number of borrowers unable to keep up with mortgage payments.

The loss of $6.58 a share compared with net income of $830 million, or 92 cents a share, a year earlier, the Seattle-based company said today in a statement. The cost of uncollectible loans jumped 58 percent to $2.2 billion from the first quarter.

Chief Executive Officer Kerry Killinger, 59, stripped of the chairman position last month, is facing increased pressure from investors after the stock dropped 86 percent over the past year and his peers from Citigroup Inc. and Wachovia Corp. were fired. Washington Mutual has been forced to raise capital, reduce the size of its home-lending business and slash 10 percent of its workforce amid mounting losses from subprime loans and adjustable-rate mortgages.

"So much of their business has been in the lower-quality loans," said Stephanie Hall, an analyst at Gradient Analytics, a research firm in Scottsdale, Arizona. The mortgages are "higher risk relative to other large-capitalization banks." The company rose as high as $6.40 after the earnings statement. It increased 34 cents or 6.2 percent to $5.82 at 4 p.m. today on the New York Stock Exchange and has tumbled 57 percent this year.

Washington Mutual said it plans to cut $1 billion in costs, which will contribute to "improved pretax, pre-provision earnings." Provisions for losses increased to $5.9 billion from $3.5 billion in the first quarter. Hall said she expects $9.6 billion in bad loans over the next 12 months.

Washington Mutual, known as WaMu, was the last of the six biggest U.S. lenders to announce quarterly results. Wachovia Corp., the fourth-biggest, reported an $8.9 billion loss earlier today, slashed its dividend 87 percent and announced $2 billion of cost cuts. Citigroup Inc. recorded a $2.5 billion loss last week, while JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. reported drops in profit.

WaMu had $3 billion of losses in the prior two quarters as foreclosures climbed to a record. In California, home to half of the company's loans, one in every 192 householders was in some stage of foreclosure last month, 2.6 times the national average, according to RealtyTrac Inc.

America’s banking industry continued its rollercoaster ride yesterday as Wachovia, the country’s fourth-biggest bank, announced a record $8.9 billion (£4.45 billion) loss for its second quarter, the elimination of 6,350 jobs and an 87 per cent cut in the dividend.

Robert Steel, the former US Treasury under-secretary, who took over as Wachovia’s chief executive two weeks ago, said that the group would also lose, as part of its cost-cutting drive, 4,400 contractor and staff posts that were open but had yet to be filled.

Lanty Smith, Wachovia’s chairman, said: “These bottom-line results are disappointing and unacceptable. While to some degree they reflect industry headwinds and weaker macroeconomic conditions, they also reflect performance for which we at Wachovia accept responsibility.”

Wachovia’s results were pushed down as the group increased its second-quarter provision for losses on bad mortgages and other loans to $5.57 billion, from $179 million a year ago and $2.83 billion in the first quarter of 2008. Gerard Cassidy, an RBC Capital Markets analyst, said that the “credit deterioration was worse than expected”.

However, Wachovia’s shares jumped $3.61 to close at $16.79 amid investor relief that the bank was cutting costs and that it had no plans to raise money by issuing new shares, which would dilute their ownership of it. Wachovia said that it would “sell selected non-core assets” and would cut expenses by $490 million in the year’s second half and by $1.5 billion in 2009.

Much of Wachovia’s loss provisions related to Golden West’s $121 billion portfolio of home loans. About 70 per cent of these were made to finance house purchases in California and Florida, two of the biggest victims in the worst US housing crisis since the Great Depression. Wachovia bought Golden West for $24 billion at the top of the market two years ago.

Wachovia has its headquarters in Charlotte, North Carolina, down the road from Bank of America, its rival. It is essentially a retail bank, but has small investment and corporate banking and wealth management units. The results provide further evidence that the credit crunch is far from over. Stronger than expected results from Wells Fargo, Citigroup, Bank of America and JPMorgan Chase in recent days had outweighed a disappointing loss at Merrill Lynch.

However, fears began to resurface again on Monday night as American Express reported a surprise 38 per cent fall in second-quarter profits and issued a profit warning for the year. Profits at Wachovia’s retail, small business and commercial division fell 23 per cent to $1.12 billion in the second quarter. Corporate and investment banking profits fell from $779 million to $209 million over the same period.

Profits of the capital management division, consisting of retail brokerage services and asset management, fell from $312 million to $297 million. To add to banking’s misery, Washington Mutual announced last night that America’s biggest savings-and-loans institution made a $3.3 billion loss in its second quarter, after an $830 million profit a year earlier.

Almost without anyone noticing, last Wednesday financial stocks had their biggest one-day rally ever, with the financials in the S&P 500 Index soaring 12.3%.

With that, the group regained its status as the third-largest segment in the index, having slipped to No. 4 behind health care just the previous day. But it wasn't too long ago that financials were the index's largest sector, and despite last week's action, their prospects remain miserable.

"We've seen unprecedented carnage in this sector, and there are no signs it is over," says Alec Young, an S&P equity strategist. "We would urge investors not to be too tempted in this area." I confess I have been tempted, arguing that because financials took the economy down, it will be up to them to lead it back. In February, my fundamentally bullish column on the group was headlined "Financial stocks: The stars of 2008?"

The answer to that question so far: No. Events have been giving my optimism quite a thrashing. So today I'm going to suggest what I believe will be the smartest way to play this group for at least the next six to 12 months. That would be to short it, betting these stocks will fall even more.

Shorting is something many everyday investors have never done, but it's increasingly easy thanks to inverse and leveraged-inverse exchange-traded funds. Next week I'll take another look at the group from a different perspective, that of so-called value funds. Chances are you own at least one big brand-name fund that wears the value label. Supposedly this style of investing delivers the best long-term results. But value is married to financials, and that means this beaten-up shoe has a big hole in its sole.

Why? Because the gap in financials is a black hole, feeding on the despair it creates. That's also what makes the financial sector perfect for shorting. Yes, these stocks have already fallen quite a distance. If you get in too late and you're short, a serious move up can hurt you. But we've heard several times already that the worst was over, and it wasn't.

Financial-sector funds are the worst-performing equities in the world now and by a wide margin. They're down an average of 24.6% this year, even after last Wednesday's rally. Large-capitalization growth funds, which are only lightly invested in financials, have fallen only half as much.

Banks and their brethren have endured epic bear markets in the past, most recently in 1990 at the depth of the savings-and-loan crisis. But this time, at least in the market's mind, is different. Back then, the magnitude of the financial calamity could be grasped and was measured in billions of dollars. Even when it burgeoned from losses estimated at $50 billion to four times that amount, the extent of the damage could at least be understood.

Today's financial meltdown defies comprehension because so much of it is packaged into exotic derivatives, such as collateralized debt obligations and structured investment vehicles. These were bundles of risky loans such as subprime mortgages put together and sold by institutions eager to spread risk and keep lending.

Now, they embrace possibly $2 trillion or $3 trillion dollars of indebtedness spread far beyond banks and savings and loans to insurance companies, pension funds and the like around the world. The marketplace for these exotic bundles has seized up. Meanwhile, other asset-backed securities are plunging because defaults are rising amid the sickened economy

Ilargi: It may be -or just seem- quiet around the bond insurance industry, but don’t let that fool you. All underlying indicators are getting progressively worse, and eventually additional downgrades can no longer be avoided. There are no healthy businesses left in the field. Warren Buffett has turned out to be hardly a factor; his new insurer only picks the very best cherries. Ironically, that will worsen the state of the others even more.

Assured Guaranty lost almost half its market value on Tuesday after Moody's Investors Service said it may downgrade the Aaa ratings of the bond insurer. Dexia shares fell 11.5% after Moody's warned that the European bank's bond insurance unit, Financial Security Assurance, may also lose its Aaa rating.

Assured Guaranty and FSA are the only two incumbent bond insurers that have been able to hold on to their top ratings. The rest of the industry has lost its triple-A seal of approval after guaranteeing complex mortgage-related securities that soured as the housing bust deepened.

If these insurers also lose their triple-A ratings that would leave Warren Buffett's new bond insurance business, Berkshire Hathaway Assurance, as the only player in the market with a top rating, research firm CreditSights noted on Tuesday.

Moody's put the Aaa ratings of Assured Guaranty on review for a possible downgrade partly because of the complexity of the credit risks that have been taken on by the bond insurer and a drop in demand for the guarantees sold by the bond insurance industry. Assured raised capital earlier this year from billionaire distressed debt specialist Wilbur Ross.

It also avoided some of the riskier, more complex mortgage-related exposures that have torpedoed larger rivals Ambac Financial and MBIA. So Moody's warning shocked many investors. "We share the market's surprise at this move, but believe any concern about the loss of a top-tier rating will keep the shares under pressure," Catherine Seifert, an analyst at Standard & Poor's Equity Research, wrote in a note to clients.

It also shocked the company. Chief Executive Dominic Frederico said during a conference call with analysts on Tuesday that Moody's gave Assured Guaranty no early warning that its rating was going to be put on review. Assured shares slumped 44% to $10.85 during afternoon trading on Tuesday.

"We are concerned by Moody's announcement at a time when Assured is experiencing broad market acceptance and investor demand for our insured paper," Frederico said in a statement. "Moody's action is not at all reflective of a deterioration in Assured's capital base, credit exposures or earnings outlook."

Assured said it expects to report quarterly net income of $515 million to $565 million, or $5.63 to $6.18 a share. Most of that profit will come from after-tax unrealized gains on credit derivatives, which are expected to be in the range of $475 million to $525 million, the company added. Operating income, which excludes unrealized investment gains and losses, will be $38.7 million, or 42 cents a share, Assured said.

Moody's put the top ratings of rival Financial Security Assurance on review for a possible downgrade because of the insurer's exposure to residential mortgage-backed securities, which has generated "material losses." Dexia, which owns FSA, said in June that it planned to lend up to $5 billion to its bond-insurance subsidiary to boost confidence in the business amid concerns raised by Bill Ackman, head of hedge fund Pershing Square.

Dexia also pumped $500 million into FSA earlier in the year. However, that may not be enough for Moody's. In the case of FSA, the agency said Dexia's support may be conditional and might not be enough to limit the impact of possible future losses. Dexia shares fell 11.5% to 8.45 euros during European trading on Tuesday.

Assured Guaranty's exposure to mortgage securities hasn't deteriorated much and the company's recent expansion into the municipal bond market has left it with generally high-quality, diversified risks, Moody's said. However, Moody's also warned that the leverage and complexity of Assured Guaranty structured-finance deals have made loss estimates difficult to calculate.

The wide range of possible loss estimates may not be consistent with the low risks that Aaa rated bond insurers are supposed to take on, the agency added. Moody's also said that demand has dropped a lot for the financial guarantees sold by bond insurers, including Assured.

"Such dramatic instability in the firm's current and prospective market opportunity also raises questions about whether an Aaa rating remains appropriate," the agency said.

U.S. municipal bonds fell hard on Tuesday and once again the main trigger was worries that bond insurers will lose their top-notch ratings, which could spur waves of selling by fearful investors.

Another factor that could scorch muni bond prices also arose on Tuesday, turning the risks into a triple play.Three credit agencies downgraded Wachovia Corp's debt ratings, citing the risks of more mortgage losses and difficulties raising capital.

"I think the market just seems to be in complete shambles today," a New York municipal bond trader said. "And I think it's all precipitated by the two insurance companies plus the Wachovia downgrade," he explained.Wachovia backed variable rate demand notes and investors in this paper now might overwhelm the market with sales, he said.

Several bond insurers this year have lost the highest ratings their business demands, shaking confidence in the $2.6 trillion muni market. As a result, the muni market turned in one of its worst-ever showings in February though this debt, sold by states, cities, hospitals and museums, has an overall default rate of less than 1 percent.

This time, the anxiety centers around two bond insurers -- Financial Security Assurance and Assured Guaranty Corp. Late on Monday, Moody's Investors Service warned it might cut their "AAA" ratings, partly due to mortgage-linked plays.

These warnings could clip prices for top-rated municipal bonds in the secondary market by 7 basis points or so when Tuesday's trading ends, a New York muni strategist estimated. If Moody's does indeed downgrade FSA and Assured, there would only be one "AAA"-rated bond insurer left: Berkshire Hathaway. But Warren Buffett's company so far has not displayed much interest in insuring new muni issues.

Investors, especially money market funds, now might sell variable rate demand notes guaranteed by FSA and AGO, for the same reasons they could unload debt backed by Wachovia. "I think some of the money market funds held the belief that FSA was going to be impervious to a downgrade.

That's not the case," said Chris Ihlefeld, a co-portfolio muni manager at Thornburg Investment Management in Sante Fe, New Mexico. The same selling could hit AGO-backed notes, he said. The market "absolutely" could get slammed again with the liquidity problems seen this spring, he added, depending on whether ratings on FSA and AGO are cut -- and how severely.

Variable rate demand notes are backed by letters of credit and standby purchase agreements, which were supposed to ensure that investors could always sell this debt. But security in this $400 billion market vanished in February when dealers got hit with too much paper backed by troubled bond insurers.

The variable rate demand note market snarled after the $330 billion auction rate paper broke down, again due to fears that the bond insurers that guaranteed it would be downgraded. Auction rate paper is long-term debt whose rates reset periodically, but it lacks the safeguards of variable rate paper.

After bond insurers MBIA Inc and Ambac lost their "AAA" ratings, investors flocked to FSA and AGO, which raised their premiums. But now, issuers increasingly might skip insurance, especially if credit agencies harmonize their often lower ratings for munis with corporate debt ratings.

"Although both companies (FSA and AGO) have pledged to work to rebuild rating agency credibility, Municipal Market Advisors feels this may well be the end of bond insurance as we know it," wrote Matt Fabian of Concord, Massachusetts-based MMA.

On Tuesday, the county seat for Dallas, Harris County, changed its mind and opted to sell $322 million of debt without buying bond insurance, according to a market source. Buying insurance from FSA was expected to let the Texas county shave 3 to 20 basis points off the interest rates it would pay, the market source said. AGO's backing would have saved it an estimated zero to 20 basis points.

But then Moody's issued its warnings and underwriters found that "they (the customers) prefer unenhanced on Harris," the source said. The term unenhanced means without bond insurance.

The number of companies facing "critical problems" surged by more than a quarter between the first and second quarter of the year as tightening credit conditions continued to bite, according to Begbies Traynor, the corporate insolvency and restructuring specialist.

Year-on-year comparisons in the company's Red Flag Alert survey show a near eightfold rise in financially troubled companies in the second quarter. The survey showed 4,258 companies facing winding-up petitions from creditors or county court judgments in excess of £5,000, compared with just 542 in the same period a year ago. Quarter-on-quarter, the number of companies facing critical problems increased by 29 per cent.

While construction and retail businesses emerged as being particularly hard hit, the IT sector registered the biggest jump in distressed positions. Ric Traynor, the Begbies executive chairman, said gloom was spreading. "Credit lines have dried up and companies which might have been supported by extended credit up to a year ago are now at risk."

When reporting annual results earlier this month, Begbies noted that since January 1 business insolvencies were running about a third higher than last year, though 2007 was the lowest level since the early 1990s when there were about 30,000 cases a year. In spite of what is still a low number of insolvencies on a historic basis, Begbies predicted on Monday that the acceleration in companies facing critical problems would feed through to a surge in business failures.

Based on previous experience, Begbies suggested 15 per cent of companies defined as facing "critical problems" would enter insolvency procedure within 12 months. Begbies is not alone in predicting a significant rise in company failures in the second half of the year.

Ernst & Young said in May that official figures showed only a "modest quarterly rise in insolvencies" in the first quarter. But it predicted insolvencies "were set to increase at a much faster rate in the later part of 2008 and in 2009" as "credit-addled" individuals and companies found out they could not "live in 'never-never' land forever".

An outstanding trade, or just too clever by half? Morgan Stanley made a small killing when it shorted 2.25 per cent of HBOS last Friday.

What's raised eyebrows is that it was also one of two lead underwriters to the HBOS rights issue that had closed that very morning. It therefore knew it would be able to close out its short positions at a substantial profit with the shares it was about to be left with as a result of being a prime underwriter.

Morgan Stanley insists it did nothing wrong, and, indeed, that the Financial Services Authority was kept informed throughout. Unlike underwriters to the Royal Bank of Scotland rights issue, it took out no direct short position while the rights issue was in progress, though it did engage actively in other hedging strategies.

However, in terms of directly undermining an issue which it was underwriting, its hands were clean. The same could not be said of underwriters to RBS. With HBOS, it was only after the rights issue closed that the direct short position was taken. By that stage, it was widely assumed in the stock market the rights issue had flopped, though only Morgan Stanley's client relationship team would have known quite how badly.

Even if the traders responsible for the short position had been able to take a peep over the Chinese wall to see the full damage – the issue was only 8.3 per cent subscribed – it would have made no difference to their actions. As it is, Morgan Stanley insists there was no such snooping.

Overnight relief at trading news from Citi had that morning boosted the whole banking sector, so the HBOS share price briefly broke back through the rights issue price. In order to satisfy market demand for the stock, most of it from hedge funds looking to close out their own short positions, Morgan Stanley itself shorted the shares knowing full well the positions would be covered by the underwriters' stick.

The laughable part of this everyday story of City money-making jiggery-pokery is that, were it not for new FSA rules requiring the disclosure of short positions, no one would ever have known that the trade had taken place and it would by now already have been lost in the mists of time.

Morgan Stanley did nothing wrong, but the episode has nonetheless added to the general air of suspicion that now surrounds everything the City does. Having helped create the credit crisis in the first place, the investment bankers are profiting from the misery of dealing with its consequences.

And you wonder why the bankers manage to maintain their mansions in Hampstead and yachts in the south of France, while the archetypal small HBOS shareholder still lives in a hovel in Halifax. The quid pro quo for the repeated bailouts the banking system is receiving from the taxpayer right now is meant to be a greater degree of oversight and accountability, on practice as well as bonuses.

Bankers must at least show contrition if they are to avoid regulatory over-reaction. The trouble with the Morgan Stanley short is not that it was against the rules, but the way it looks.

Lenders started foreclosure proceedings on a record number of California homeowners last quarter, although the pace of quarterly increases in default activity slowed somewhat, a real estate information service reported Tuesday.

Mortgage servicers recorded 121,341 notices of default during the April-through-June period, up 6.6 percent from 113,809 during Q1, and up 124.9 percent year-ago totals, according to DataQuick Information Systems. The second quarter default activity is the highest on record, DataQuick said in a press statement; but the slowing number of new defaults has led to some speculation that the run-up in default activity may be nearing an end.

“The small increase in defaults from the first to the second quarter may indicate that we’re nearing a plateau,” said John Walsh, DataQuick president. “We won’t know until the end of the year, but it may be that some lenders are starting to prioritize workouts with homeowners instead of grinding things through the foreclosure process. “Of course, they may just be swamped and can’t handle processing any more paperwork,” he said.

Last quarter’s default numbers were a record in almost all of the state’s 58 counties, as well. That included Los Angeles County, where last quarter’s 21,632 residential defaults surpassed the prior record of 21,444 recorded during first-quarter 1996.

Perhaps most telling, however, was the finding that only an estimated 22 percent of troubled borrowers emerge from the foreclosure process successfully — in other words, nearly 80 percent of those that default on their mortgage in California are losing their home.

As DataQuick noted, this isn’t likely evidence of a failure on the part of servicers; it’s evidence of just how far so many borrowers got in over their heads during the housing boom. “The increased portion of homes lost to foreclosure reflects the slow real estate market, as well as the number of homes bought during the height of the market with multiple-loan financing, which makes ‘work- outs’ difficult,” the company said.

Foreclosures made up 40 percent of statewide real estate resales last year, up dramatically from 5.4 percent one year earlier. Merced County has perhaps been the hardest hit, with more then 75 percent of all resales in the county in the second quarter coming from foreclosed real estate.

Mortgage approvals for house purchases dropped to a new low in June, falling 66.4 per cent compared with the same month last year, according to figures from the British Bankers' Association (BBA).

The annual fall was the biggest since BBA records began in September 1997 and shows that the downturn in the housing market is accelerating as lenders restrict the granting of mortgages. The figures come just a day after government figures showed that the number of British homes changing hands almost halved in June, highlighting the difficulties facing estate agents, homebuilders and retailers.

David Dooks, director of statistics at the BBA, said: “Another record low number of mortgages approved by the banks for house purchase means that the whole market is likely to be at its least active since the early 1990s.” Despite the decline in the number of mortgage approvals, total mortgage lending rose by £3.8 billion in June — an increase of 12 per cent on last year's figures. However, this is the weakest rise since at least October 2007.

The downturn in the property market is also feeding through to household finances as people are becoming more wary of racking up credit card bills, according to the BBA. "The pressure on household finances is being reflected in subdued consumer borrowing, with spending on cards lower than of late and borrowing on personal loans and overdrafts being comparitively weak," Mr Dooks said.

Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyers, said: "The continuing lack of availability of mortgage finance is proving a major drag on the level of property transactions and is increasingly being felt in the real economy. The modest cuts in the costs of borrowing seen over the past few weeks will unfortunately provide little relief for first time buyers.

Indeed, the fact that Tim Besley voted for a rate hike at the latest MPC meeting suggests that it is premature to expect the Bank of England to provide any support anytime soon." Remortgaging accounted for a record 55 per cent of mortgages approved in June. In contrast, just 19 per cent of mortgages were approved for house purchases.

Credit-card borrowing remained subdued during June, with £7.3 billion spent on plastic, in line with the recent trend. Consumers also repaid more than they spent, continuing the pattern of the past two years. New spending was 2 per cent higher than a year ago but lower than in May, reflecting the lowest number of purchases since last July. Borrowing on overdraft was lower for the ninth consecutive month and gross unsecured loans remained subdued.

Ilargi: If you’re still wondering why mortgage approvals in the UK are an endangered species, look no further. British banks can’t raise capital no matter what they try; they can’t even sell their assets anymore. England can stiff upper lip as much as it likes, but it can’t go on like this much longer.

Royal Bank of Scotland looks increasingly likely to shelve plans to sell its insurance arm and turn instead to other smaller deals to top up its capital.

RBS announced plans to sell Britain's largest car insurer in April. But the operation's trading conditions have deteriorated and its top suitors have pulled out -- leaving the bank with the unpalatable prospect of selling an attractive asset at a steep discount to its target price tag of around 7 billion pounds.

The outcome, bankers and analysts say, could be scrapping the sale of a unit that they say RBS was never keen to sell, boosting its balance sheet instead with other sales. "It looks now as if there is a less than 50 percent change they will sell the business," said Leigh Goodwin, analyst at Fox-Pitt Kelton. "If they didn't get the right price from Zurich, why would they get a better price from Allstate?"

Zurich Financial Services had been seen as the front-runner to buy the insurance arm but pulled out last month, leaving Germany's Allianz and U.S. firm Allstate as the last serious bidders, people familiar with the matter have said. Travelers has also been named as a suitor, though its interest has cooled.

"Clearly RBS would have liked the flexibility ... but most investors would rather they didn't sell the business in a forced sale. It's not as if it's a bad business, and selling it would be dilutive to earnings," FPK's Goodwin said. Britain's second-largest bank said in April it was targeting a core tier one ratio of more than 6 percent at the end of this year -- taking on a bigger capital cushion than in the past to protect it in more turbulent market conditions.

That target, however, includes both the bank's record 12 billion pound rights issue, completed last month, and a 4 billion pound boost to capital from asset disposals -- most of that from the sale of RBS Insurance. Its core tier 1 ratio was under 5 percent before the fundraising, one of the lowest in the industry, after its purchase of parts of ABN AMRO and big writedowns stretched an already tight balance sheet.

The ethanol industry, until recently a golden child that got favorable treatment from Washington, is facing a critical decision on its future.

Gov. Rick Perry of Texas is asking the Environmental Protection Agency to temporarily waive regulations requiring the oil industry to blend ever-increasing amounts of ethanol into gasoline. A decision is expected in the next few weeks. Mr. Perry says the billions of bushels of corn being used to produce all that mandated ethanol would be better suited as livestock feed than as fuel. Feed prices have soared in the last two years as fuel has begun competing with food for cropland.

“When you find yourself in a hole, you have to quit digging,” Mr. Perry said in an interview. “And we are in a hole.” His request for an emergency waiver cutting the ethanol mandate to 4.5 billion gallons, from the 9 billion gallons required this year and the 10.5 billion required in 2009, is backed by a coalition of food, livestock and environmental groups.

Farmers and ethanol and other biofuel producers are lobbying to keep the existing mandates. “This is a critically important decision that will determine the future of biofuels in this country,” said Brent Erickson, a lobbyist at the Biotechnology Industry Organization, which supports the ethanol mandates. “There will be a dramatic reaction from whoever loses.”

The E.P.A. received 15,000 public comments on the Texas proposal, roughly split between those in favor and those against.LHT Inc., an infrastructure company, said it never would have spent tens of millions of dollars developing delivery pipes for ethanol without the mandated increases. “How do we get our money back?” an executive asked.

O.K. Industries, a poultry company in Arkansas upset about rising feed costs, said this was the first year since the company was founded during the Great Depression that it could not afford to give its employees a wage increase. An agency spokesman said the E.P.A. can approve the request, deny it or take a middle path. The deadline is Thursday, but the agency says it needs more time to review public comments and formulate a decision.

The agency’s authority derives from a 2005 energy law that sets some of the most important ethanol quotas. The law says states can petition the agency for a reduction in the ethanol mandates on the grounds of severe harm to the economy or environment. Decisions must be made after consultation with the secretaries of energy and agriculture.

Ethanol is under siege from other quarters. Senator Kay Bailey Hutchison, Republican of Texas, has introduced legislation calling for a freeze of the mandate at the current level, saying it “is clearly causing unintended consequences on food prices.” The measure is co-sponsored by 11 other Republican senators, including John McCain, the presumptive presidential nominee.

The Federal Reserve chairman, Ben S. Bernanke, testified last week that “it would be helpful” to remove a 51-cent-a-gallon tariff on imported Brazilian ethanol. If Brazilian ethanol enters the United States market, domestic producers argue, the industry will suffer.

moral hazard will be taken not just to a whole other level, but into a different dimension, and a universe unknown to man. A small step for man, a giant leap for mankind.

Great English on that, ilargi, just the curve I need to hold up the polly tent I am building.

We're in the *veggies*,were in the veggies,we got a lot of what it'will ' take to get along.

Something somewhat more serious from the US Bureau of Statistics:

The number of unemployed persons was essentially unchanged in June, a t8.5 million, and the unemployment rate held at 5.5 percent. A year earlier,the number of unemployed persons was 7.0 million, and the jobless rate was 4.6 percent

A measly .9% change looked at one way or 17.6% more unemployed, over the year, looked at another way.

What do you figure the kindling percentage will be? Big day for Paulson, are you giving odds at all?

(*veggies* sorry to use such bad form, but needs must when the noble word 'vegetable' didn't scan.)

To Quote: "Congress takes that for granted, that it makes me suspicious. How is that in the best interest of the people they have been elected to represent?"

your analysis is as always excellent and thought provoking. However you seem to operating under a misapprehension. While 'publicly' congress is elected to represent the interest of their constituents they are privately elected as the handmaidens of the vested interest which means the rick and powerful. Need I spell out the obvious conclusion of this fact?

Can you explain the incredible run up in financial stocks in the last couple of days? Even Eric Dash of the NYT is scratching his head in disbelieve. I have four theories:

1) They have gone stark, raving mad2) De Boyz put in de fix3) Fall out of the short squeeze from Cox and the SEC4) Idiots think that the problem is the commodities bubble, so the drop in crude prices will cure all from athlete's foot to pancreatic cancer.

A lot of people that were shorting financials have to cover their positions by buying them, thereby reinforcing there every thing that they were betting against. It's called a short squeeze, and it won't last long.

This morning dropping from 48 to 26 in a little over two weeks, HORIZONS BETAPRO NATURAL GAS made a 3%+ recovery this morning and then proceeded down ward to end at 23.88.

I don't trust this market!

I just caught on the CBC afternoon Financial show that Congress approved an unlimited line of credit has been granted to Fannie and Freddie, did I hear right? They got the whole ball of string, or was it misreported, misheard? Don't they have another bit of a hurdle tomorrow?

the Bloomberg interview of Faber is available on their site. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=af89KR4uyEGI

at one point (10:35) Faber talked about credit crunch and the impact on economy as something never seen in his life time (in terms of the speed of the deceleration in credit growth) and is "very very negative impact on the economy and that's very sure." yet at the end, Faber still think the worst case scenario ahead is a colossal bust with inflation simply because we have money printing institution around the world called central banks.

Just leaving a reminder for everyone who gets excited about voting for Obama that they're being fooled around and played for dummies. Still, Obama holds no strings, no more than Bush or Cheney. They are all powerless. Power doesn't rhyme with visibility. These puppets are waved in your face to provide a focus for your anger, so you have no attention for what goes on behind your back.

High gas prices work the same way: the house is on fire, and you are steaming because the TV reception is distorted.

Also, this is not run-of-the-mill routine work. Raising the debt ceiling by $800 billion happens only once a year, and setting up your voters for a newly-minted fresh $5.2 trillion debt in one fell swoop whammy is a first.

As I said, they tried Bear Stearns and not only got away with it, they were mostly praised. Now the bar is set a few notches higher, and it seemed appropriate to point out that.

Looking at the FDIC and the hundreds of banks about to push dandelions, it's time to wonder what Fannie and Freddie are a dress rehearsal for.

Karl Denninger gets angrier every day, and tells people to call and write their congress person. Much as I sympathize, I saw the system for what it is, and by no means just the American one, since way back when as I was so much older. I'm younger than that now.

Ilargi,As I said, they tried Bear Stearns and not only got away with it, they were mostly praised. Now the bar is set a few notches higher, and it seemed appropriate to point out that. [...]

Karl Denninger gets angrier every day, and tells people to call and write their congress person. Much as I sympathize, I saw the system for what it is, and by no means just the American one, since way back when as I was so much older.

So how come we are fools if we don't do something about it? What are we supposed to do, sit on a pile of dollars and immolate ourselves in public places? Bear Sterns went sailing on by because everything is in the pocket of the unseen powers that own the media, legislative, administrative...

Don't take the fool thing too personally. The vast majority of the body politic are fools because they allowed the snake charmers to hypnotize them. As long as people who see clearly represent a small minority, all we can do (for the moment anyway) is shout from the hilltops and try to prepare for the apocalypse. Anything more leads to a waterboard or rendering to Syria or lard.

I hate these moments when right up to the wire I hoped that Congress would reject the plan. Alas...same old same old.I am recalling another moment in history when Russia invaded Hungary. I was a fresh faced kid in high school. My history teacher came to school wearing a black armband. Something never before seen in my northern Ontario town. He was taking the invasion so personally and he wasn't even Hungarian! Just like I am taking current events as a personal loss even though I am not American.

Comment from July 20; The Grief Cycle:No debt at all is best if you can manage it, as is having liquidity (cash and cash equivalents such as short term treasures) under your own control. Ideal you should have at least several months to a year's worth of liquid funds if you can manage it (which is a big 'if' for most people unfortunately).

I'm in the lucky situation that I have these things covered. I own my own apartment (which I'm sure will drop like a stone in value of course but I need to live somewhere), I make decent money, have a pretty secure job for the next few years (in Norway, related to oilfield development), and I live way below my means.

I realize that "penny-pinchers" like me are - in a deflationary environment - probably really unproductive for the economy (as in not stimulating it) seen from the angle of government, with the exception of banks recycling my accumulating deposits in their fractional-reserve manner. So I wonder what happens in these situations - do governments introduce additional measures to get me started spending my savings instead of accumulating more, or are our deposits in banks worth more to the economy than I would be as a Good Consumer (I fear the modern view is that they are not). Anything like this going on during the 30s or later in deflationary Japan? In Norway, we do of course already have real-estate tax, fortune tax, capital income tax on earned interest, etc. I am thinking about these kinds of things, if history has revealed any tendencies to how these things might change...

““8 million Americans are now listed in Main Core as potentially suspect” and, in the event of a national emergency, “could be subject to everything from heightened surveillance and tracking to direct questioning and even detention.”

The alleged use of Main Core by the Bush administration for surveillance, if confirmed to be true, would indicate a much deeper level of secretive government intrusion into Americans’ lives than has been previously known. With respect to civil liberties, says the ACLU’s Steinhardt, it would be “pretty frightening stuff.””http://cryptogon.com/?p=3059

The "funds allotted to Social Security" are simply treasury debt like any other treasury debt, or as the Chimp in Chief says, "merely pieces of paper" (like the Constitution). In the 1980's it was decided that SS was in trouble with the baby boom, so they jacked up SS taxes hugely to amass a surplus. The money needed currently was routed directly from payroll taxes to "geezer" checks, and the remainder converted to treasuries. The money was then spent on Humvees and Scottish golf outings for Senators. The surplus is reputed to continue for a few years. With the collapse of the economy, payroll taxes will fall rapidly, resulting in a major shortening of the surplus time window.

In my opinion, even our current crop of congress people would be fearful of diverting the surplus, but I doubt they are going to "redeem" the treasuries for very long.

I turn 62 next month. I can collect 80% of the 66 year old rate even though I am still working and will have to pay taxes on it. Going to take that money while the getting is good, maybe convert it to Euros or gold, and stuff it in my mattress.

“Make a note on your calendar somewhere that what we're seeing here may very well be a prequel to a bigger economic decline to come this fall, and with that will come a major increase in blame. If history is any guide, the liquidity-providing "speculator" will again take the heat.” When All Else Fails Blame the Speculators

Karl Denninger gets angrier every day, and tells people to call and write their congress person. Much as I sympathize, I saw the system for what it is, and by no means just the American one, since way back when as I was so much older. I'm younger than that now.

what do you mean when you say "i have seen the system for what it is"? I have just recently become aware of the breadth and depth of our current situation and can see that there is something deeper going on but do not understand what. could you please explain a little?

Oh and thank you for running such an informative blog. It has really opened my eyes; although i now feel like a deer caught in the headlights. I have just woken up to the existence of the matrix and am not quite sure what to do with myself :(

Reading "Why wasn't IndyMac on FDIC problem list?" I kept thinking: "I've SEEN this movie!". This is JAWS. Bad for tourist business to suggest there is a great white in the water.

On CNN last night I think Chris Dodd was hinting at the great white in the water. He mentioned more than once, in talking about the housing bill, that FOREIGN countries were getting very nervous, and basically forced some of the particulars of the bill. Could that have been the part [which of course will almost certainly probably not be used] about using taxpayer funds to buy shares of private stock [to maintain foreign shareholder "confidence"?]. ??

And if worked on Freddie and Fannie, how long before we see it again... propping up some other private company with taxpayer dollars. We taxpayers will default on our homes before we'll risk angering the IRS thugs [mainly because the IRS takes their pound of flesh up front]. Does that make taxpayer dollars the last secure "investment"? Are we the shareholder/buyer of last resort?

I realize that "penny-pinchers" like me are - in a deflationary environment - probably really unproductive for the economy (as in not stimulating it) seen from the angle of government, with the exception of banks recycling my accumulating deposits in their fractional-reserve manner. So I wonder what happens in these situations - do governments introduce additional measures to get me started spending my savings instead of accumulating more, or are our deposits in banks worth more to the economy than I would be as a Good Consumer (I fear the modern view is that they are not).